Avoid credit dings when mortgage shopping
How to steer clear of 'borrower in distress' label
By Jack Guttentag
Borrowers in distress often contact many lenders hoping to find one who will approve them. For this reason, multiple inquiries can have a negative impact on a consumer's credit score. But multiple inquiries can also result from loan applicants shopping for the best deal. The challenge to the scoring system is to distinguish borrowers in shopping mode from borrowers in distress mode.
Hard inquiries vs. soft inquiries
Consumers need not be concerned about inquiries they make, such as ordering a credit report. Self inquiries don't affect the credit score. Neither do inquiries from your existing creditors, potential employers, or businesses considering whether or not to solicit you. These are sometimes called "soft inquiries."
The inquiries that may affect your credit score are those by new credit grantors to whom you have given your Social Security number along with explicit authorization to check your credit. These are "hard inquiries."
Distinguishing borrowers in shopping mode from those in distress: The ignore rule
Two credit-scoring rules developed by Fair Isaac Corp., which pioneered the development of credit-scoring models, are designed to protect the scores of borrowers who shop multiple lenders for the best deal. The quotes below are from www.FICO.com.
The "ignore rule" is that "the score ignores mortgage, auto, and student loan inquiries made in the 30 days prior to scoring."
The 30 days includes the day of the score, which is not evident from the wording. It is a good rule, but borrowers are not warned about other types of credit that are not ignored. A very important one is credit cards. Because I happened to need a new business card while researching this article, I decided to see what impact my card shopping would have on my score.
I had a mortgage lender friend make a credit inquiry to obtain my score, then I shopped two card issuers and had my friend inquire again. My score had dropped 13 points. All credit card inquiries are treated as indicators of distress.
Mortgage borrowers today face the hazard that the 30-day period can expire while their loan is still being processed. If the lender decides to recheck the borrower's credit, which some do as a standard practice, the mortgage inquiries that had previously been ignored will then hit the score.
Distinguishing borrowers in shopping mode from those in distress: The consolidation rule
The "consolidation rule" is that "the score looks on your credit report for mortgage, auto, and student loan inquiries older than 30 days. If it finds some, it counts those inquiries that fall in a typical shopping period as just one inquiry when determining your score."
The consolidation rule is expressed in such a way that most readers interpret it to mean that mortgage, auto and student loans are consolidated together. That is how I read it originally. In fact, what it means is that all mortgage loans are consolidated, all auto loans are consolidated, and all student loans are consolidated. If you shop for one of each type, they constitute three inquiries.
The shopping period during which inquiries are consolidated is 15 days in one version of the scoring model and 45 days in another. Because borrowers don't know which model is being used by their credit grantor, they should assume the period is 15 days.
But the most serious concern about the consolidation rule is whether the scorers can accurately associate inquiries with the correct loan type, especially in the case of mortgages.
Does consolidation always work?
One of the motivations for this article was a claim made to me by Jack Pritchard, a long-term mortgage veteran, that mortgage inquiries were not always consolidated because the reporting system did not always identify them accurately.
I posed this issue to Fair Isaac Corp. and was told that "the credit reporting system is a voluntary one and ... lenders report what they choose to report to the bureaus, and each bureau represents that information a little differently on its credit reports."
While this reply confirmed that proper identification could be an issue, Fair Isaac claims that their systems work around this problem by giving the borrower the benefit of any doubt. If the system is not sure, it consolidates.
But this leaves open the possibility that the system has no doubt but is wrong. Pritchard pointed to mortgage inquiries from credit unions and finance companies as particularly prone to misclassification because other types of loans are originated out of the same offices. At his suggestion, I asked Fair Isaac what would happen if a mortgage shopper generated an inquiry from a credit union and a finance company?
The reply was that "the credit inquiries would in all likelihood be de-duplicated by the FICO scoring algorithm. Inquiries from both credit unions and finance companies are eligible for de-duplication." The italics are mine, and clearly suggest that there is no assurance that "de-duplication" (Fair-Isaac-speak for consolidation) will occur.
Bottom line for now
A case can be made that loan inquiries should be added to the list of borrower characteristics, such as sex, race and ethnicity, that, as a matter of public policy, can't be used in developing credit scores. The information could continue to be compiled and provided to lenders, but could not be used by the credit-scoring algorithm.
Meanwhile, borrowers shopping for credit should minimize the number of hard inquiries by ordering their own score, which does not count as an inquiry, providing that score to all the vendors they shop. You tell them that they can check your credit when you are ready to authorize it. This will reduce the number of hard inquiries to one, from the vendor you finally select. And do not seek new credit cards during the period you are shopping for a loan.
If you would like expert advise and representation in your next move, please contact me.
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Thursday, August 4, 2011
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